Market analysis - 16 agosto 2007-

The King of The Quants Takes A Hit

NEW
YORK -- Hedge fund manager Jim Simons of Renaissance Technologies is viewed with
awe in financial circles as much for his amazing track record as for the concentration
of intellectual and computing firepower he has placed at his disposal, but even
he couldn't escape unscathed from the recent turmoil in quantitative investing.
The secretive fund management company Simons founded back in 1982 actuallyperformed
well relative to its few peers in terms of size and sophisticationsuch as
Goldman Sachs Group Inc. (GS) and AQR, with its main fund reportedlykeeping
percentage losses in the single digits as of last week. Still, like withfailed
hedge fund Long Term Capital Management nine years before, Renaissance'sstumble
has shown that even a world-class roster of scientific minds can'tprotect
it from the vagaries of the market and the effects of too much moneychasing
the same strategy.

No Special Sauce

Renaissance's track record
is undoubtedly impressive and its confidence hadbecome correspondingly high.
Led by eminent mathematician and former government code breaker Jim Simons, it
had been planning to increase its flagshipRenaissance Institutional Equity
Fund to as much as $100 billion, which, withleverage, would have held positions
of about a quarter of a trillion dollars, around 175% long and 75% short. Its
long track record might have led Renaissance to think that it had cracked the
elusive code of the financial market itself, but a senior executive at a competing
quantitative asset-management firm said that its techniques were not different
enough. "When you start to think you've got the special sauce, someone
else (probably)has it too," said the executive. The executive said that,
even though statistical arbitrage strategies aren't as similar as recent media
reports have suggested - the correlation is about 15% - high leverage and the
growing popularity of the strategy made risks higher than what they appeared to
be. "Models are supposed to mimic what's going on in the market, but
when you getthese exceptional movements, you can't capture that irrationality,"
said KennethKapner, president of quantitative training firm Global Financial
Markets Institute. "When these guys put these positions on, is there enough
room to get out? A price on a screen doesn't mean anything - in abnormal market
conditions, you have to be sure there's enough liquidity." David
Viniar, chief financial officer of Goldman Sachs, told clients in a conference
call Monday detailing Goldman's own quant funds' steep losses that the unusual
dislocation in stock prices last week was a 22 standard deviation move. In other
words, it should not have happened in the entirety of human history if returns
are what statisticians refer to as log normally distributed. Similarly, the 1987
stock market crash should not have happened either. Clearly unusual moves can
and do happen, meaning that basing models on even a 150-year history of stock
prices can miss disastrous outliers. Simons acknowledged as much in an Aug. 9
letter to investors detailing the 8.7% loss over the first six trading days of
August. "We have been caught in what appears to be a large wave of de-leveraging
on the part of quantitative long/short hedge funds," he wrote. Renaissance
ignored several requests for further comment about its performance and operations.

Not Just Eggheads Turning On a Computer

Prospective investors
couldn't help but be impressed by the marketingliterature for RIEF. The computing
power assembled for research and tradingwould be the envy of any university
and its staff bios read like the roster ofan Ivy League scientific faculty
with some of the leading minds in physics, mathand computer science. One of
RIEF's portfolio managers, George Zweig, is bestknown for discovering the
subatomic particles known as quarks. On Wall Street, though, money talks.
Beyond the army of PhDs, the performanceof Renaissance's former flagship Medallion
Fund, which has been closed toinvestors since 1993, is its main calling card.
It generated a 36% compoundannual return since 1989 after hefty fees - a stunning
record. To put this intocontext, a $100,000 investment in the fund would have
grown to almost $19million by now and close to $100 million if no fees were
deducted. RIEF was designed to be a much slower-trading fund than Medallion
with up to5,000 stock positions that would "achieve superior rates of
return with lowvolatility and a relatively low beta compared to the S&P
500." The firm uses anover 1,500 processor Linux cluster with five Solaris
6800 Sunfires with 300terabytes of disk space just to do research - a collection
described as "huge"by a computer industry professional. Though powerful
computers have augmentedRenaissance's success, the asset-management executive
stressed that a fund'sperformance is a direct result of intellectual capital.
"These things are all black-box, computer-driven algorithms, but they'reprogrammed
by smart people and, when you look at the trades, they make sense,"said
the executive. "Sometimes people characterize us as eggheads who just turnon
a computer and that's it." Renaissance is aggressive about maintaining
that edge, as an ongoing legalbattle shows. The firm recently settled a high-profile
lawsuit against hedgefund Millennium Partners LP, which hired two physics
Phds fired by Renaissancein 2003 for refusing to sign non-compete agreements.
The two physicists, PavelVolfbeyn and Alexander Belopolsky, have not settled
and contend that Simons isusing the lawsuit to intimidate existing Renaissance
employees. In its complaint, Renaissance said that the knowledge taken by
Volfbeyn andBelopolsky could have earned them "hundreds of millions"
using intellectualproperty that it had spent a fortune amassing. The physicists
wrote in astatement provided by their lawyer that Renaissance's alleged secrets
"arenothing more than general ideas that are well known to people familiar
withstatistical arbitrage and quantitative finance" and went on to say
that thiscould hardly cause direct financial damage to Simons, who earned
$1.7 billionlast year according to media reports. For his part, Kapner
views Renaissance's aggressiveness as something seen to agreater or lesser
degree at most black box trading firms. "They're all secretive because
they think their models are better than otherpeople," he said. The
extent to which overconfidence in their model's superiority translatedinto
excessive size and leverage by quant funds was evident in the steep lossesof
the past few weeks. "People are just losing sight of what they were
doing," he said. "We used tohave a saying on the trading floor:
the greedy become the needy."